- Trading has been whippy this morning thanks to heightened concerns the government could be forced to bail out the GSEs and rumors circulating about the health of LEH. FRE-25% and FNM-15% fell in the pre-market and opened lower after former St. Louis Fed President Poole stated that chances are increasing that the US may need to bail out the GSEs. Multiple commentators were out defending the firms later in the morning. A UBS analyst noted that FRE's CFO told him the company sees worsening credit performance and additional losses but believes its revenue is improving, while an FRE spokesperson noted the firm has "absolutely enough capital." In testimony before Congress, Treasury Sec Paulson said that OFHEO had told him FRE and FNM are adequately capitalized. LEH-10% and GM -8% have also been casualties, especially after Paulson said that financial firms "must be allowed to fail" (he also noted his concern that some believe firms are "too big to fail"). Elsewhere in financials, WB-9% after guiding well under estimates yesterday and increasing sentiment the Co. will not be sold after confirming Treasury's Steel will be the next CEO. Dow's $18.8B offer for ROH+65% is helping to counter the bad news in financials; Dow's $78/shr offer represents at 73.9% premium to ROH's closing price on 7/9. Berkshire Hathaway and the Kuwait Investment Authority are also getting a piece of the action, providing $3B and $1B in financing, respectively. June same store sales were largely positive (ICSC total June SSS were +4.3%, or +1.9% ex WMT), as expected, but seem to have been bumped up by a boost from the stimulus rebate checks. The majority of stocks are lower with WMT losing ground after trading up $1.50 initially, while JCP-7%, BONT-3.5% and LTD-4% missed estimates and are falling. Meanwhile other discounters BJ, FRED and COST all beat estimates, as did department stores TGT-4% and KSS-6%, but are losing ground.

- Treasury markets moved to session highs as equities made new lows 1 hour into the NY session, but yields have since recovered with a rebound in stocks. The 10-year yield continues to hover at the 3.8% mark while the 2-year is fixed near 2.40%. Fed fund futures are holding onto recent gains with the Nov contract still not quite fully pricing in a 25 basis point hike three meetings out, and the October putting those odds at roughly 50% by early this fall.

- The dollar has weakened in morning trading as renewed concerns swirled over the health of the financial sector. FX dealers focused on Paulson comment that financial firms "must be allowed to fail," prompting the market rumors regarding the imminent demise of the usual suspects. ITraxx Crossover Index continues to reflect the financial market stress as it lingered in the mid 550bps range. The concerns are not just isolated to the US as an S&P report out this morning examined concerns regarding credit quality in Europe. Gold is benefiting from the crisis in paper confidence as it moves above the $940 level in the spot market. USD sentiment is also being weighed down by economic sentiment. FX dealers are noting that seasonal factors can be attributed to "better" initial claims data, focusing instead on increased continuing claims, which rose to five-year highs. The EUR/USD cross is approaching the 1.58 area, while USD/JPY continues to lack any momentum to sustain breaks of its 200-day moving average seen at 107.48

- Commodity-related crosses are also benefiting from continued geopolitical concerns as Iran conducts a second day of war games in the Gulf and keeps firing test missiles. USD/CAD is probing below the 1.01 level towards its 100-day moving average and recent hourly lows. Carry-related pairs seem immune to the market turmoil for the time being. The EUR/JPY cross is approaching the 169 area while the EUR/CHF cross is maintaining a foothold above the 1.62 handle.